In our last Podcast, I had a conversation with Steve Crandall, Vice President in charge of Implementation Services here at Technomic Asia.  We talked about how important people are to a winning China strategy … how to look for them, recruit them, train them and keep them.  After we were done recording it, I asked Steve if he thought that maybe we were being too “basic” … that this was stuff that people already know.  He said, “People might know this stuff, but its always good to be reminded of it … knowing and doing are two different things.”

Well, it turns out that Steve was right … because since we posted that Podcast, we have had LOTS of comments on how useful the information was and how important it was to revisit the basics.  So to that end, we are going to go “back to the basics” again in terms of thinking about China and building your China strategy.  This is particularly critical during these times in the corporate business planning cycle … the silly season where bold strategies are considered and aggressive plans developed.  And China – given its centrality to most global business plans – is susceptible to such ridiculous hopes, dreams and schemes.  So let’s go “back to the future”, if you will, and think about our China strategies from the beginning.

Click on the links to listen to today’s Podcast …

Here on the China Business Blog and Podcast, we focus on being very logical and very practical … at least as logical and practical as China allows one to be.  Over the 25 years we have been working in China, we’ve seen a lot of experimentation, trying this and that to see what works.  We’ve even done a fair amount of it ourselves … and that’s fine for many multinational companies with deep pockets who can afford to try this and, if it doesn’t work, try that.

However, there is a group of companies for which this experimentation approach doesn’t always work so well … the Small- and Mid-sized Enterprise or as they are commonly referred to, the SMEs.  And that is the theme for a new series here on the China Business Podcast – The SME.

To discuss this topic with me, we are going to bring in the newest member of the Technomic Asia team, Steve Crandall, who recently joined us as Vice President in our Implementation practice.  We have been seeing a need lately to increase our capabilities in helping our clients execute their organic strategies in China – setting up manufacturing, hiring, establishing sales teams and pipelines, executing a sourcing strategy etc.  Steve comes to us with a long history in China, starting in the 1980s when he was a student here.  Steve went on to set up the first foreign owned car dealership in China when he set up Crandall Ford up in Tianjin (Steve comes from several generations of Ford dealers back in Ohio).  He then went on to start up several manufacturing and sales operations for SMEs in China, incubating them until the client was ready to take over.  After a stint at Ernst and Young where he had to wear a tie to work everyday, he came to join us.  Steve has been a good friend for a number of years and we are thrilled to have him in the Technomic Asia family.

There is no standard definition of the SME, just as there is no standard definition of the Multinational Corporation, or MNC.  However, generally, the SMEs are defined by their size – less than 500 employees – and their ownership – privately held or invested by a private equity company or other financial backer.  Now I’m sure I’m going to get some letters about this … because some subsidiaries of MNCs essentially have to stand on their own and really act like SMEs.  As my teenagers say: “Whatever!”  The key commonality here is that an SME is facing the same challenges in China as any other company here but they often have less global experience to work from and they typically do not have such deep pockets to do a lot of experimentation.  They have to get it right the first time.

Over the coming weeks, we are going to explore some issues that impact SMEs in unique ways such as HR, manufacturing, sales, operations, etc.  You will be hearing many of the same themes that we’ve been hitting for years here on the China Business Podcast … but we will be discussing them as they impact the SME and will explore several unique ways that we’ve seen SMEs handle these issues.

We begin the series today with the age-old issue of market opportunity …

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Full transcript of today’s podcast:

In a recent podcast, I talked about how we at Technomic Asia think that many sectors in China today are in a “pre-consolidation” phase where, we believe, that we are going to see a lot of the smaller companies in many industries falling away and the bigger ones getting bigger. I talked about the potential for some interesting acquisition plays in 2009 for the right company to come in and lead this consolidation. We’ve had some really good response to this podcast and some good questions so I thought I would continue the topic this week.

I was in a meeting a couple of weeks ago with a client of ours, a foreign consumer products company that is looking to acquire a local company here in China. One of my senior managers and I were talking with their division president from their overseas headquarters and their China GM in charge of this division, along with various other financial and legal reps on their deal team. We were talking about the M&A process in China – what to do, the pitfalls, how long it takes, etc.

The Big-Big Boss asked me the question that EVERYONE asks in this situation: “What are the chances of success for doing a deal in China?” Not able to resist a chance to be smarmy, I responded, “Well, if you do it right, you’ll probably see over a 60% hit rate. But if you want to mess it up – and most seem to be wanting to do that – the rate is closer to 25%.”

Thankfully, the Big-Big Boss got the distinction and my lame attempt at injecting humor in a very serious question. Then, better than any straight-man in a comedy team, asked me the next question, a great set up: “So, Kent, how would we really mess this one up?”

So in this week’s podcast, I am going to tell you, verbatim, what I told this deal team and am titling it, “China M&A: How to mess up a deal, possibly wrecking both your company and your career.” OK, I didn’t quite respond with that level of sarcasm, but you get the idea…

So, here, in order of importance, are the 4 steps to doing a bad deal in China:

#1: Make no attempt to understand the market environment in which you are acquiring a company.

You are thinking to yourself, “Oh, this is going to be a good podcast, starting out stating the obvious like that.” But you’d be surprised at how many companies come to China to acquire a company and they don’t really understand the market environment in which the targets live and work. We were contacted recently by the CEO of a company who wanted to look for acquisition targets making a certain kind of product. There are, conservatively, about 500 companies doing this type of product in China. I asked him what applications were most attractive; what types of distribution they needed to have; did they need R&D; how about certifications? There was a pregnant pause and the CEO said, “I don’t know, they just need to make the product.”

No. Wrong answer. Successful China M&A starts with a deep understanding of the market and a VERY detailed checklist of the criteria of an attractive candidate, the criteria that makes the target attractive in THIS market. If the market I am working in has a particularly fragmented distribution structure and several key customer segments, then I am going to want to look at the targets that have both solid distribution and a really good sales team into those customers. It sounds really simple, but again, you’d be surprised at how many companies overlook this when coming into China.

You are going to want to pay particular attention to the requirements for distribution in China. Too often, we see foreign companies come here with what they think is a “great product” but since they don’t understand the often-fragmented distribution chains here, they don’t really know how to get it to market. I would say that nearly all of the acquisitions we do here put “effective distribution” very high on the list of criteria for assessing targets. Distribution is the one thing that takes a long time to build in China and tends to be regionally fragmented. If you can come in and buy that distribution and start to run your own products in parallel with the target’s, then that can be a “win” all around.

So though it might seem obvious, get a shopping list together before you head into an M&A program. Deep dive the market to understand what products are out there, what customers want, and how the competition is getting product to market. Only then will you be able to determine the list of criteria that makes for an attractive target. We typically spend the first part of a project developing and refining that list – it might seem tedious at first, but if you have a good criteria list, then it makes the rest go much faster.

#2: The second way to mess up a deal in China is to go after the first company you find.

A good M&A process – like a good sales process – starts with a good pipeline. If you have a number of prospects in your sales pipeline, you are going to be able to work all of them at the same time. The right ones will close and some will fall away. If you have only one deal in your pipeline, you are going to kill yourself to close it, even if it is not closeable.

The same goes for M&A – if you only have one company you are considering, and if you REALLY want to do a deal, you are going to do whatever you can to make that deal work, even if it is the wrong deal. You should arrive at your acquisition targets through a rigorous process of elimination, starting with that criteria list I talked about. Take that list and find as MANY companies in China as you can that come anywhere near fitting that list. Then start doing commercial due diligence on them, all at the same time. Get as much information as you possibly can about all of them, and then you can compare this information and benchmark them against each other.

“How many” companies should I consider, you ask? It might seem like an unanswerable question, but those are my favorite kinds! In truth, I think you need to have at least 10 companies on your “Long List” – this is the list of companies that somehow operate in this market and on which you have a certain high level of intelligence (and in some cases, we’ve had as many as 30). Then I think you need to have at least 2-3 on your “short list” … these are companies that you have researched very deeply and know a LOT about them. You know their commercial practices (distribution, pricing, bribes, etc.), manufacturing (processes, costs, suppliers, etc.) and their management (who they are, where are they from, what is their reputation, who really owns the company).

Your short listed companies should have also indicated a level of interest in doing a deal with a foreign company. We’ll talk below about HOW to approach them but, for now, hear what I am saying: You should have at least 2-3 companies that fit your criteria and who have shown an interest in doing a deal. Certainly, you will prefer one over the others, but at least you’ll have back-ups. If you have only one option, you are, essentially, going into a deal and are trying to “marry your first date”. You could be in trouble. You NEED options and it is your responsibility to go find them.

#3: Ignore the importance of relationships in China

The 3rd way to mess up a deal in China is related to the first … and that is to ignore the importance of relationships in China when starting deal discussions. The Western way to get a deal started is often to have the CEO of one company call the CEO of another company and they start talking. Sure, sometimes intermediaries like brokers or investment banks are used, but direct is a valid approach as well and is often preferred. At least in U.S. business culture, “directness” and “openness” is valued and boss-to-boss communication is often the best way to do that.

Too often, we see foreign companies use this same method in China, going directly to a potential acquisition target and start discussions, saying too much, too soon, before they have done any kind of due diligence on the target. They even rely on the target to tell them about the target’s business and the market. But in China, where standards of accounting and business practices are still in their early stages, you cannot rely on a target to either really understand their market or their company the way YOU need to understand them. And in Chinese business culture, going through intermediaries is often preferred so that both sides can explore things slowly without having to confront the principals directly and risk either side losing face.

The consumer products company I was talking about in the introduction to this podcast fell into this trap. They are a large, well-known global company with a very large group of super-smart MBAs in their deal team. When they want to do a deal, they send these Men (and Women) in Black who do a deal the way they are used to doing a deal … approach the target, sign an NDA, validate the target’s financials and go from there. Well, they basically did that here in China … before getting ANY market intelligence on the target, they approached one of the biggest players in the China market and started talking about ways they could cooperate. The target was, of course, VERY interested in this large, well-known company that wanted to do a deal with them, but they were a bit befuddled as to how to properly respond. So they did the only thing they knew how to do and they pulled out all the stops to show what a good acquisition target they could be and why a VERY high price would be justified. After many months, LOTS of documents being passed back and forth (including letters of intent that discussed possible valuations) not to mention untold dollars spent on the deal team’s resources, the Western company’s senior management suddenly realized that what they were hearing from the target did not seem to make sense in the market and that they had no objective view of the target or the market.

That’s when they called us, to come in and do the due diligence on the target – which is fine! We love doing this and we are VERY good at what we do. And in this case, we found out that there were some huge problems with the target: they had been losing market share rapidly, their management was clueless and many of their distributors were angry and in danger of jumping ship (none of this information, of course, was included in the presentations that the target did when our client approached them directly … then everything was hunky dory and getting even hunkier and dorier!). This is NOT an uncommon finding in China; however, since our client had already had very deep discussions with the target – including discussing deal structures and valuations – there was no room to move with this new information.

If our client would have done the commercial due diligence FIRST, before ever approaching the target, then they would have been MUCH better prepared to discuss the details of a deal and would have had tons of objective market intelligence to challenge the target with.

We did a program like this a few months ago, for a large high-tech company where we had 9 China targets on the “long list” and on whom we did a pretty deep level of due diligence. Two companies came out of that effort as the leading targets – we knew who they were, their ownership, their advantages in the market, their warts. Everything! We also were able to get a high level of confidence from the target’s ownership that they were interested in talking to a foreign company about potential hook-ups.

The key here, is that we were able to get all of this information ANONYMOUSLY … none of the 9 companies knew who our client was. Now, we were able to put our client in a VERY strong position where they know a lot more about the targets than the targets know about them. We can make the introductions and continue to act as a “middle-man” of sorts to facilitate the communication. Our client is able to keep the conversation going with several of the targets at once, only committing themselves once they absolutely have to (usually around the time that they need to sign an LOI).

If our consumer products client had done this, knowing what they know now, they might not have approached their target at all. But like my point earlier, they had NO back-up plans … they didn’t have a short list … so there was no where to go from here. It is really too bad because our client wasted a LOT of time, effort and money to get to a point of no return and they had to start at zero again.

#4: Relying too much on financial wizardry

The fourth and final way to mess up a deal in China is to assume that the value you create is going to be done through balance sheet re-engineering and NOT through improving the commercial practices of the target. In the West, the heroes of the M&A deal teams are the financial wizards, the quant jocks who can read a dense balance sheet like a primary school textbook and then apply complicated techniques to squeeze more value out of it. A Private Equity firm we work with did just this with a recent acquisition of a $25 million company, finding an extra $1 million in EBITDA that the original owners did not have the experience to locate. I am not naïve here … of course this is not the ONLY value that is created from M&A in the West, but it is a key goal for many acquiring firms, be they strategic or financial.

But in China, this does not work so well; rather, value in an acquisition is created by helping the target become a better player in the market. To a great extent, this starts with very often not having an accurate balance sheet at all … remember, you ask a Chinese company to show you their books and they will often say, “sure, which ones?”. This even applies to the larger, publicly traded companies – we found this to be very true in the due diligence we did on this consumer products company – there was a broad discrepancy between their stated sales and the actual tax receipts that could be associated directly to those sales.

No, foreign companies who acquire Chinese companies need to be thinking, first and foremost, of creating value by upgrading the target’s commercial practices, working with them to find the right products, at the right prices going to the right customers through the right channels. For the consumer products company, we identified big gaps in the target’s distributor management processes that were contributing to their loss of market share. Our client is quite well known for how they manage distributors and, though their practices would need some “China-fying” we identified several key areas where value could quickly be created.

With our high-tech client – the one with the 9-company long list – it was a different situation. The targets had very good channel and distribution practices (this was one of the key criteria for selecting them); however, what all of them lacked was a solid foundation in R&D, an area in which our client is a global leader in their sector. We identified areas where upgrading the targets’ R&D capabilities could reap great rewards in the market, by promoting Western technology at a China price.

The value created is, of course, very different in each situation – but the fact remains that, more often than not, this value is going to be in the commercial area and NOT in reorganizing the balance sheet.

So…if you really want to mess up a deal and risk destroying both your company and your career, I just gave you the roadmap! I am assuming, of course, that this is NOT the case. So what should you do?

Well, if you already have a target identified, sit with your deal team and assess what you do or do not know about the China market situation (point #1 above) and what other possible targets might be out there (my point #2). If you are in talks with a target and find that things have stalled, a good way to shake things up is to start talking to another target: it provides you with some perspective and signals to the first target that you have options!

If you are just considering growth in China via acquisition, then you have the freedom to start things off correctly. Walk through points #1 and #2 by fully understanding the market and all of your options. Then you can find a way to approach these targets in an IN-direct fashion and find ways where you can add value by improving their commercial practices. Trust me, when you reach the point of pulling the trigger on a deal, you will be MUCH more confident if you’ve first eliminated most of the ways that you could possibly mess it up.

Thanks again for spending time with us. Remember our motto – and it particularly applies to M&A in China – “In China, everything is possible but nothing is easy.” We’ll see you next time on the China Business Blog and Podcast.

China’s auto aftermarket moves into high gear

SHANGHAI — Sept. 9, 2008 — Parts and service in China’s light passenger vehicle market reached an estimated US$27 billion in 2007, driven by strong expansion and continued aging of the vehicle parc, according to new research conducted by Technomic Asia, an international market consultancy specializing in China strategies for U.S. companies.

The report, titled “A Strategic Assessment of China’s Light Passenger Vehicle Aftermarket, Fourth Edition,” stems from Technomic Asia’s ongoing primary research into the Chinese auto marketplace and its key players. Other major findings indicate that the light passenger vehicle car parc has expanded to more than 32 million units, with middle-aged vehicles (4-9 years old) reaching a 41 percent share. More information is available at http://www.technomicasia.com/auto.

“The aging and expanding parc, coupled with private ownership of vehicles at almost 70 percent today, supports strong growth in the parts and service market,” said Steve Ganster, managing director of Technomic Asia and primary author of the report.

“The market is fragmenting as more vehicles from recent market entrants, notably the Japanese, hit the road,” Ganster said. “Both local and international parts and service companies are aggressively developing their infrastructures to penetrate this dynamic market. Though many challenges exist, the outlook for growth remains robust, with the market expected to expand at 19 percent per year through 2012.”

This unique China auto report offers valuable statistics, insights and analyses to assist management to successfully address this important market, including:

• Perspective on China’s automotive market, including a long-term growth outlook for China’s light vehicle market in terms of types of vehicles, key OEMs, growth drivers and constraints, etc.
• Overview of the automotive aftermarket in terms of parts and service, covering size, segmentation, parts types, key players and trends
• An assessment of China’s automotive parc in terms of size, vehicle composition, age, technology base and future growth
• A description of the maintenance and light repair service market, covering outlets, services provided, value, etc., and current and forecasted 2012 value by vehicle and service type
• A description of the collision repair market, covering the insurance market, accidents rates, service providers, service value, etc., as well as current and forecasted 2012 value by vehicle type
• A description of other major and minor spot repairs in terms of value, repair type, segmentation by age of vehicle and vehicle type, growth vector and key trends
• Collision repair market, covering the insurance market, accidents rates, service providers, service value, etc., as well as current and forecasted 2012 value by vehicle type
• A detailed evaluation of the parts supply chain, with descriptions of structure, key players, pricing characteristics and future dynamics
• Perspective on key opportunities and challenges facing players in China’s automotive aftermarket

For more information on the report, or to purchase a copy, please visit www.technomicasia.com/auto or call our offices at +1-919-855-5437 (U.S.) or +86-21-6473-2588 (China).

Technomic Asia’s own Kent Kedl will present highlights from the report along with other chamber leaders and industry experts, including AmCham 2008 Chairman-elect Nor Coquillard, Jeffrey Bernstein of Emerge Logistics, and Stephanie Liu of Armstrong World Industries. This year’s report offers insight into responses on a wide range of challenges and topics, including the top 2007 China business challenges, business performance, strategy and goals, the operating environment and local Shanghai issues.

“One of the most prominent issues facing companies doing business in and with China right now is product safety,” Kedl said. “Whether you’re making food or toys or pharmaceuticals, or even sourcing from China, vetting your supply chain and maintaining tight control over the product you’re selling is paramount.”

The “Launch of the AmCham Shanghai – 2007 China Business Report” event will take place at 11:30 a.m. on Friday, Dec. 14 at the Four Seasons Hotel in Shanghai. For more details, contact AmCham Shanghai at (8621) 6279-7119 or amcham@amcham-shanghai.org.

China’s automotive aftermarket is a growing, complicated market. A new research report from Technomic Asia offers some insight and statistics on the Chinese auto aftermarket. Steve Ganster, CEO of Technomic Asia and author of “The China Ready Company,” discusses some highlights and lessons from this new report. Steve discusses trends in the industry and some of the risks and challenges businesses face in China. Of interest for auto-related companies and others with an interest in China.

Learn more about the report at www.technomicasia.com/auto or e-mail Steve at sganster@technomicasia.com.